ETF Focus

Beware the Buyback Strategy

Some investors expect stock buybacks to increase along with the tax on dividends. And, of course, there are a handful of ETFs ready to capitalize on this strategy. But it may not prove as profitable as investors expect.

Thank You

Error.

A tax increase on dividends seems all but certain: that's why we're seeing a spate of late-year special dividends from companies like
Wynn ResortsWYNN -0.8547829427583558%Wynn Resorts Ltd.U.S.: NasdaqUSD103.23
-0.89-0.8547829427583558%
/Date(1438376400309-0500)/
Volume (Delayed 15m)
:
2805805AFTER HOURSUSD103.217
-0.013-0.012593238399690013%
Volume (Delayed 15m)
:
41483
P/E Ratio
22.889135254988915Market Cap
10481665115.4807
Dividend Yield
1.937421292260002% Rev. per Employee
298350More quote details and news »WYNNinYour ValueYour ChangeShort position
(ticker: WYNN) and asset manager
Franklin Resources BEN -1.3214904679376083%Franklin Resources Inc.U.S.: NYSEUSD45.55
-0.61-1.3214904679376083%
/Date(1438376719143-0500)/
Volume (Delayed 15m)
:
4131064AFTER HOURSUSD45.55
%
Volume (Delayed 15m)
:
109817
P/E Ratio
12.211796246648793Market Cap
27959409120.3171
Dividend Yield
1.3172338090010978% Rev. per Employee
892065More quote details and news »BENinYour ValueYour ChangeShort position
(BEN). No one can say with certainty (though many have tried) how the market will react if individual investors have to pay a higher tax on dividends. One theory is that company executives will argue that repurchasing stock is more attractive, since dividends will return somewhat less money to shareholders. For investors who think that stock buybacks are the next chapter of the story, there happen to be a few exchange-traded funds whose purpose is to track buyback-friendly companies. But think before you invest: There's precious little evidence that share repurchases do much for long-term investors.

Roughly one-third of the $2.7 trillion in S&P 500 buybacks over the period 2004 to 2011 was loss-making, according to a Credit Suisse study this year, and the money that was spent wisely usually didn't reap much. Little wonder, as repurchases peaked in 2007 right around the S&P 500's high. That points to the reason buybacks fail so often: Most companies buy at precisely the wrong moment. Companies usually buy for reasons other than value, like offsetting employee stocks sales or inflating earnings per share. As a result, companies often buy back shares when prices are rich. If dividend taxes drive more of them to buy back stock, the usual motives will still rule, says Credit Suisse quantitative strategist Pankaj Patel. The health-care and consumer discretionary sectors are two places to watch for the buyback-dividend trade-off. Both buybacks and dividends are widespread there.

There's only one fund in this niche to beat the S&P 500 this year: The
TrimTabs Float Shrink TTFS 0.1562228779725742%TrimTabs Float Shrink ETFU.S.: NYSE Arca57.7
0.090.1562228779725742%
/Date(1438376354637-0500)/
Volume (Delayed 15m)
:
8854
P/E Ratio
N/AMarket Cap
N/A
Dividend Yield
0.5847660311958406% Rev. per Employee
N/AMore quote details and news »TTFSinYour ValueYour ChangeShort position
ETF (TTFS), up nearly 13%. This one twins the search for stock-supply reducers with screens for quality, such as avoiding backdoor diluters or share-buyers who use too much borrowed money. Few investors have enjoyed the ride, however, as the fund has just $10 million in assets. Perhaps that's because, at 0.99%, this one is also priced for true believers.

The timing of buybacks is important because sudden buybacks usually happen at the wrong time—and the companies that repurchase stock suddenly are often in the most trouble. A better approach may be a lot simpler: Firms that consistently buy their stock at low prices are usually also attractive for other reasons. Investors could do worse than to ignore buybacks altogether and keep searching for low price-to-earnings ratios, reasonably priced growth companies, and the low-cost funds that track them.